As China becomes the largest market in the world for one product after another, companies with products, technologies and services needed by the country’s rapidly-developing economy are all trying to do the same thing — establish a position in the Chinese marketplace. Depending upon the human and capital resources available, there are a variety of ways to accomplish this objective.

While much of what follows may be old hat to MTD readers experienced in China, we thought it would be useful to summarize the different paths to China for those hoping to tap into the China market. In Part I, we will review ways to access the China market without making a capital investment, and in Part II, which will follow as our next post, we will review those that require capital.

Sales/Marketing/Distribution Agreement

The simplest and most straightforward way in which to enter the China market is to establish a sales, marketing or distribution agreement with a Chinese company, or a foreign company with a distribution organization in China. Although it is no easy matter to find the right distribution partner, and the importance of this first step should not be underestimated, the principal advantages to a sales or distribution arrangement are that, once a partner has been identified, the financial and human resources required of the company are relatively minimal.

The principal disadvantage is that the price of a product sold through these types of arrangements is likely to be too high to gain a meaningful share of the China market. Given the high level of manufacturing sophistication in China, there are very few products that cannot be made more cost effectively in the country than in most other manufacturing economies. It is the rare product today that is more expensive to manufacture in China due to some unique technology or raw material requirement. When a product is manufactured in a high-cost country, shipped to China and subjected to a distributor mark-up, the end result is a very high landed price. In most cases, only a small segment of the China market will be able to afford such a high price.

The other disadvantages are the lack of market visibility and control over critical items such as price and service that the exporter is likely to have under these types of arrangements.

Representative Office

Establishing a China representative office is a very common first step for international companies to take. Representative offices are fairly simple entities and do not require a capital investment. For these reasons, many companies choose to set up a rep office in order to gain experience and a better understanding of the China market. Companies also often use a rep office to oversee their other operations in the country.

A representative office is not a separate legal entity, but an extension of the parent company. Its mission is to act as a liaison between the home office and trade organizations or related industries in China. A rep office may only engage in non-profit making activities such as providing data and promotional materials to potential clients and partners, conducting research, liaising with government officials and other contacts, and acting as a coordinator for the parent company’s activities in China.

A rep office is restricted from directly engaging in any business for profit. It may not receive fees for services provided, sign contracts or deals on behalf of the parent company, represent any firm other than its parent company, issue invoices or collect money, buy property, hire employees or import production equipment.

Despite its many limitations, a rep office does provide a physical presence in the country, and that fact alone is an important indication to potential customers that the company is serious about the China market.

Contract Manufacturing

In order to take advantage of China’s lower manufacturing costs and be in a position to offer lower prices to consumers, a company may identify a manufacturer to produce its products in China under contract. A contract manufacturing arrangement typically does not require a capital investment, other than the resources needed to transfer know-how and technology to the manufacturer and to monitor quality.

The principal advantages of contract manufacturing are that it does not require capital, and the company need not become involved with the difficulties of managing a business in China. The principal disadvantages are that it may be challenging to control the quality of the end product, and contract manufacturing involves some level of know-how and technology transfer under circumstances where the company can expect to have little control over its intellectual property.

Licensing Technology

Many companies have accessed the China market over the years through technology licensing agreements whereby the company transfers the product specifications and manufacturing technology for certain of its products to a Chinese manufacturer. The licensee manufactures and sells the product under the terms of a license agreement, which typically defines the “field of use” as China, Greater China, or perhaps Asia.

License agreements typically have a 10-year term, and require the licensee to pay the owner of the technology some combination of an upfront fee, royalty payments based on sales, and per diem and travel expenses of the engineers who help transfer the know-how and technology.

The obvious advantages of a licensing agreement are that it enables a company to monetize the value of its technology, does not expose the company to the difficulties of managing a business in China, and does not require a capital investment. In fact, licensing agreements generate cash and have a positive earnings impact.

The obvious disadvantage is that licensing agreements can, in effect, create a company’s future competition. Once the license agreement ends, it’s not possible to take back the technology and know-how that’s been transferred, and field of use restrictions go away. When China’s economy was much smaller and less well developed, companies were more willing to license technology than they are today when the competitive threats from China are much more apparent.

While all of the above represent relatively low cost ways into China, gaining an important share of the market will require an investment of capital and manufacturing in-country. In our next post, we will review the paths available to those companies that wish to participate in a more meaningful way in the China market.